Bill Ackman (Trades, Portfolio) is not new to making history. Earlier this year, the guru shorted the broad market to net a profit of over $2 billion and was quick to load up on high-quality stocks at the market bottom in late-March. So far, his track record during the current economic downturn is second to none in comparison to the performance of other investing gurus.
In his latest move, Ackman raised over $4 billion by publicly listing a special-purpose acquisition company (SPAC), commonly known as a blank-check company. This venture trades as Pershing Square Tontine Holdings (PSTHU), and trading commenced on July 22.
This type of company is basically an empty shell created to raise funds for some special purpose, such as acquisitions. By monitoring the developments of this special purpose investment vehicle, investors might be able to uncover an attractive investment opportunity.
The fundamentals behind blank-check companies
A blank-check company does not have any business operations. These are structures used by well-known investors to raise capital to fund future acquisitions. Investors who buy units of such companies are betting on the ability of the management team to find acquisition targets at attractive prices, after which the units would be converted into common shares of the acquired company.
In recent years, the average size of IPO transactions related to SPACs has increased, indicating the growing trust among market participants toward these innovative investment vehicles.
The potential rewards to investors of the SPAC depend entirely on the eventual success of the company that would be acquired in the future. The risks of investing in this type of company, therefore, are quite high.
However, prudent investors might want to follow the developments of a SPAC carefully for a different reason: to identify lucrative investment opportunities in undercover, unpopular stocks.
Why investors should keep an eye on Pershing Square Tontine
Source: Pershing Square Holdings
With $4 billion at his disposal for the SPAC, which could increase to as much as $7 billion if additional units are issued to the market, Ackman would be hunting for bargains amid these challenging macro-economic conditions. The investment decisions of this SPAC will reflect the guru's thinking about the expected performance of equity markets in the coming years.
According to the documents filed with the Securities and Exchange Commission, Pershing Square Tontine will look for four types of companies as acquisition targets:
- Private companies that are in strong financial health but are finding it difficult to list their securities on a stock exchange as a result of the economic recession.
- Mature unicorns, or large private companies that are disrupting the industries they represent.
- Private equity portfolio companies seeking liquidity.
- Family-owned businesses in search of capital.
Speaking on CNBC, Ackman reiterated his belief that the U.S. economy will recover and said:
"We are long-term bullish on America; We are long-term bullish on the markets. But I would say I'm cautious on markets over the next period of time. We have today a short position in a high-yield index. We are bearish on highly levered companies. The highly levered businesses will struggle because it will take time for the economy to reopen. I don't think the Fed is going to bail out companies with too much debt."
Going by his comments, the SPAC is likely to invest in a company that is not excessively levered so as not to fall into a debt trap. On the other hand, the management team of the investment vehicle might expedite the process of identifying a suitable acquisition target as deals could turn out to be expensive once the economy recovers from the current lows.
So far this year, SPAC mergers have made it to the headlines on a few occasions as a result of the successful listing of common shares of companies such as Nikola Corporation (NASDAQ:NKLA), DraftKings Inc. (NASDAQ:DKNG) and Virgin Galactic Holdings (NYSE:SPCE). The company chosen to be acquired by Pershing Square Tontine could become the next big thing in this space as it would be backed by some of the smartest brains in the industry.
According to U.S. News, the following large private companies are looking to raise capital by listing their common shares on stock exchanges this year:
- Procore Technologies
- Casper Sleep
On July 22, Airbnb reported that a SPAC has approached the management team to strike a deal to take the company public, and this could be the start of many such offers for renowned private companies. The volatility in global capital markets, on the other hand, might prompt many companies to consider using this innovative vehicle to raise capital and list their securities.
Mitigating the risks as outside investors
Carefully evaluating the downside potential of a certain investment goes a long way in helping investors generate market-beating returns. Monitoring the developments with Pershing Square Tontine to gain insights into Ackman's thinking is one thing and deciding to go all-in on the stock of the company that would be acquired by this SPAC is another thing. It is common practice for the management team of such an investment vehicle to include clauses that would tilt the odds in favor of the founders of the company, and the guru might walk away with millions of dollars in profits while another investor could sit on losses.
As Renaissance Capital senior strategist Matthew Kennedy said:
"SPACs can be extremely lucrative for the founders, who typically take a healthy chunk of equity at a nominal value, as well as the IPO advisors, lawyers, and bankers involved with the IPO and eventual M&A deal. However, it's worth noting that SPACs have been a mixed bag for long-term investors."
Retail investors would essentially be starting from behind, so the best course of action is to carefully analyze the fundamentals of the company that would be acquired by the SPAC before reaching an investment decision.
Ackman has had massive success over the last one and half decades, and things have been no different this year. On July 22, Pershing Square Tontine entered record books as the SPAC that raised the highest amount of capital from investors, which is a feat that was only possible because of Ackman's involvement. Keeping an eye on this new investment vehicle could help investors unveil a very attractive investment opportunity in a young company that is prime to grow according to the guru.
Disclosure: I do not own any stocks mentioned in this article.
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This article first appeared on GuruFocus.